Everything in moderation, including moderation. — Oscar Wilde
While overall I find this pretty good life advice, it also has applications for personal finance. Here I’ll focus on how you can apply this motto to building your portfolio — though it can also be applied to saving (it’s OK to take that vacation or go to that concert!).
Once you make the decision to invest in individual stocks, some generally good advice is to not put all of your eggs in one basket. Build a balanced portfolio and all that. And, for the record, that is good advice, and you will hear me preach it often. However that doesn’t mean you should blindly follow it when you are still in the process of building out your portfolio.
Sometimes fantastic companies go on sale and it creates a once-in-a-decade opportunity to really load up on high quality companies at a price you can almost never get them at. Think 2008-2009. Coca-Cola was trading at $15 per share — a P/E of 13. This is a company that has raised dividends every year for half a century and historically had a P/E in the low to mid 20’s. So we are talking a 50% discount and a starting dividend yield of 6%. 6%! For Coca-freaking-Cola. That’s absurd.
It’s times like that I’m perfectly happy to break the balanced portfolio rule.
I am actually a proponent of taking an unbalanced approach to building a balanced portfolio. Say you are just starting out. Maybe you have a list of 5-10 stocks you are excited about, but don’t have a ton of money to save yet. I think using year 1 to select what you think is the best value 1 or 2 of those stocks and focusing on them is a great way to go. At the end of year one you may end up with a 100% concentration in just one stock. And that’s OK. Year 2 you can choose another 1 or 2, and by year 4 or 5, you have what is starting to look like a balanced portfolio.
There are a few reasons I’m partial to this approach. One is the fees for buying 10+ stocks multiple times a year will add up. Another reason is psychological. When you are new to income investing, it is sometimes hard to see the light at the end of the tunnel. Let’s say you invested $800 in each of 10 stocks at an average yield of 3%. Every quarter, each of your stocks will pay out around $6. Nice, but honestly a low enough amount that can lead to some frustration.
Now let’s say you take the 1 conviction stock route. Now your $8,000 is going into one company. Once every 4 months you are getting $60 to be reinvested. A little more exciting than $6, even though overall it’s the same amount of money being reinvested.
The difference is it is easier to see the compounding effect when you are dealing in larger quantities. Once you can see it and understand how it works for you, it becomes addicting. You want to find another $8,000 to invest in another company and start the process all over again.